Stronger dollar helps Eurozone, but is not enough

We currently prefer non-European equity markets. However, should the ECB become more aggressive (leading to higher nominal growth expectations), our preference would undoubtedly shift back towards the Eurozone. This may be a theme for 2015.

The stronger US dollar versus the euro has already changed things somewhat in favour of Europe. Earnings momentum has turned positively, for example. In the US, this indicator is falling while in the Eurozone earnings momentum is grinding higher towards a more neutral level. The 4-week average earnings momentum in the Eurozone is now higher than in the US (see graph).

The US Q3 earnings season starts in two weeks’ time. Currently 5.5% year-on-year growth is estimated. Three months ago, the market was still expecting 8.3%, so expectations have been reduced in the usual pattern. Sequentially, this would imply an earnings decline for the first time since Q3 2008. This may look exceptional but over a longer time frame it is not unusual to see earnings drop in Q3 as a consequence of the holiday season. This year another factor may interfere: a stronger dollar. Nevertheless we think this impact will still be fairly limited in Q3 but will play a more prominent role in Q4, due to base effects.

## Slowdown in US earnings is a risk factor for US equities

A slowdown in US earnings is a risk factor for the US equity market. After all, US equities are primarily driven by earnings. Higher effective tax rates (stricter legislation on tax-inversions) and lesser benefits from low rates are additional US earnings headwinds. We see little room for higher valuations given that the Federal Reserve will start a gradual tightening path in 2015. If at that time the trend in Eurozone earnings is not strong enough due to domestic economic weakness and a slowdown in China, we might see heavy headwinds for global equities. We think this risk is higher for the next earnings season (early 2015) than for this one. Therefore, we maintain our small overweight position in US equities in our tactical asset allocation stance.